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With the global industry heading into another maturity phase, BusinessWeek reports that Outsourcing has also slowed down.

The very surprising part is the statistics:

The quarterly figures from outsourcing advisors TPI show the total
value of outsourcing deals signed in the first three months of the year
was $17.6bn, compared to $25.4bn a year earlier - the lowest first
quarter figure for five years.

This is fairly typical though — new IT budgets are made in early January, but with a 4-5 month sales cycles these projects start by early in second quarter and payments come to outsourced vendors in the third quarter onwards. Fourth quarter is also slow.

However, part of the report points to another interesting statistic:

One of the reasons for the slowdown is the fall in the number of US
companies outsourcing their IT. The TPI figures show a dramatic drop of
70 per cent in the value of US outsourcing contracts for the first
quarter of 2007 to $5.2bn.

Although the report says that Europe is going strong, it will be soon that they will start slowing down as well.

Why is this happening?

The outsourcing boom lives on the assumption that big corporations will look to shed all of the fat from their operations and try to become a lean system to create higher margins.

There is only so far that you can go with this however, especially since quality drops from outsourcing at more than twice the rate that costs drop. The increase in the overheads for a firm in quality control and program management often outweigh the total value created from outsourcing the functions in the first place.

While that is an old debate, here is a new one: What happens when you’ve run out of places to lower costs in order to increase margins? What if you cannot lower costs any further, but still have to increase margins in order to stay competitive?

The paradigm shift here involves looking at cost-cutting as a value-adding strategy, to looking at strategic positioning as a value-adding strategy.

Companies are increasingly looking to Management Innovation as a means of achieving differentiation. You will see this in both startups trying to create massive scalability against minimal marketing expense in the “Web 2.0″ space, or in large corporations such as Walmart and Dell experimenting with new Business Practices. You will even see this locally in our telecos such as Mobilink

Strategic innovation requires a top-quality team to execute before the competition does. It requires full transparency and control over the systems, process, policies and activities undertaken by the business, and it may require proprietary systems that help you differentiate.

As such, there becomes an incentive to bring back in the resources requires to create that strategic value, and work with partners who understand innovation as a value-enabler.

What this means for Pakistan or IT Firms in General

The big question is this: As more and more companies stop or slow down their outsourcing and move into strategic value creation, how will our local companies survive?

In my view, there are two ways of surviving in that future: One is by shifting your focus from an “outsourced IT company” to a “Managed Services Partner”.

Managed Services vendors armed with an army of domain experts will become the key partners for big corporations in this shift.

Companies such as Techlogix that are spending the money to source the top talent in Financial Management, Risk Analysis, Supply Chain, Telecom Infrastructure Management etc. are making the right moves and will come out to be a formidable contender in the long term.

The other way of addressing this slowdown is by through innovation. Creating the Systems, Infrastructure and Processes required to differentiate and becoming a supplier of benefit rather than a reducer of cost will be important.

The challenge for Pakistan’s IT industry is: How can we start moving ourselves from a simple outsourced / BPO player to a higher-value partner? Where do we find the people? How do we train them? How do we market our industry’s ability to add value? How do we create the environment which lets the smaller IT players take bigger risks?

What happens when one day outsourcing stops and people stop caring about us?